PRESENTED BY: YAP SOO HAR

TAXATION OF MICRO AND SMALL

BUSINESSES IN MALAYSIA –

HOW TO DEAL WITH INFORMAL ECONOMY

THE FOURTH IMF-JAPAN HIGH-LEVEL TAX

CONFERENCE FOR ASIAN COUNTRIES

(2-4 APRIL 2013)

INTRODUCTION

Definition

An informal economy refers to activities and income that are

partially or fully outside government regulation, taxation and

observation. This type of activity allows employers, paid

employees and the self-employed to increase their take-home

earnings or reduce their costs by evading taxation and social

contributions. (World Bank)

Why tax informal sector?

• To avoid over taxing formal sector, negative consequences for

on competitiveness and growth, undermine social cohesion

and fiscal losses.

3

…INTRODUCTION

Literature on taxation of micro businesses advocates-

•Good tax design:

- wide base

- clear, simple and transparent system

- separate thresholds for micro-enterprise, small and medium

enterprises

•Tax base:

- presumptive tax based on turnover

- cash flow: simple cash receipts and payment basis

for micro-business (Ireland)

•Tax administration:

- minimise compliance costs and streamline procedures

- reduce administrator discretions

- encourage voluntary compliance, outreach programmes

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APPROACH

1. Tax Profile and Taxation of Micro and Small Business in Malaysia

2. Understanding Micro and Small Businesses through Economic

Profile from the SME Census 2011 produced by SME Corp

3. Moving forward

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…DEFINITION

SME Corporation (an agency established to spur the development of

small and medium enterprises in Malaysia):

Sector Criteria Micro

Enterprise Small Enterprise

Medium Enterprise

Manufacturing

Manufacturing related services

Agro-based Industries

Sales turn over Full time employees

<RM250,000

<5

RM250,000 – <RM10,000,000

5-50

RM10,000,000 - RM25,000,000

51-150

Services Primary agriculture ICT

Sales turn over Full time employees

<RM200,000

<5

RM200,000 – <RM1,000,000

5 - 19

RM1,000,000 – RM5,000,000

20 - 50

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PROFILE OF SMEs

SME Census 2011 is a set of survey data collected from

registered businesses and firms

Exclude smallholders, farmers, households and individuals

Census 2011 provide an account on micro, small and medium

businesses operating in the formal economy in Malaysia-

- Total respondents: 662,939

- Total SMEs: 645,136

- Total employment: 3,669,259

SME Census as a proxy to understand operations of micro

businesses in the informal economy

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DEFINITION OF SMEs

Ministry of Finance:

Companies with paid-up capital of RM2.5 million and below

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…PROFILE

Micro- Enterprise Small Enterprise Medium Enterprise

Total SMEs 77% 20% 3%

Involvement in economic sectors

Services (79.6%) Manufacturing (57.1%) Agriculture (56.3%)

Mining & Quarrying (42.1%) Manufacturing (36.8%) Construction (34.9%)

Mining & Quarrying (38.8%) Construction (20.6%) Agriculture (14.8%)

Total employment

36.5% - Services (91%)

40.1% - Services (68.1%) - Manufacturing (24.5%)

23.4% - Services (45.2%) - Manufacturing (31.5%) - Construction (18.1%)

Source: SME Census 2011

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SMEs IN THE NATIONAL ECONOMY

Source: SME Census 2011

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TAX PROFILE OF SMALL BUSINESSES (Micro, Small & Medium Enterprises)

Year of Assessment 2011

Sector SMEs Micro Business/ Sole Proprietors

Wholesale and retail Repair of motor vehicles & motorcycles

25% 1.7%

Construction 14.6% 3%

Manufacturing 11.1% 2%

Agriculture, hunting & forestry 10.2% 6%

Finance & insurance 5.5% 4%

Technical & scientific professional services

5.1% 0%

Land development, rental 1.1% 4.5%

Others 27.1% 78.8%*

Total Tax Paid (RM mil) 15,004 2,308

Source: IRBM * 76.6% has no / incorrect code

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•Based on SME Census 2011:

1. Legal structure of SMEs - 71% individual proprietorships,

18.4% private limited companies and 8.5% partnerships

Enterprises operating in the formal economy are

incorporated entities. The legal structure excludes micro

business proprietors and partnerships from being eligible

to claim tax incentives which are available to incorporated

entities eg. tax holidays

The actual number of enterprises operating in the informal

economy cannot be estimated. These enterprises are

unregistered and operate on a cash basis

ECONOMIC PROFILE

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…ECONOMIC PROFILE

•Based on SME Census 2011:

2. Employers make up 18.7% (working proprietors, active business partners and unpaid family workers) compared to 77.7% (2.85 million) full time employees and 3.6% part-timers

Pull factors for informal economy - risk takers, bear unlimited liabilities, handle mostly cash transactions and unpredictable sales and profits

Changing nature of operations – employ less locals and more foreign workers who are less monetary demanding and prepared to work longer hours. Employees unlikely to fall into tax net

As local entrepreneurs age, they employ foreign helpers or become renters

If no contribution made for social security, health insurance and employees provident fund, no need to move into formal economy

Requires time and resources to be tax compliant – proper accounts for business, employ tax agent to file returns and provide tax estimates for monthly deduction of self and employees, if eligible.

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… ECONOMIC PROFILE

•Based on SME Census 2011:

3. Financing

(%) FI RE F&R Others (grants)

Overall 20.3 55.9 14.3 30

M-E 16.2 58.1 15.0 28.8

Small E 30.7 49.6 12.7 33.6

Medium E 47.7 46.4 8.5 35.5

Micro-enterprises fall below the radar.

Pull factors to remain in informal economy-

limited access to loans from financial institutions (FI)

rely heavily on profits/retained earnings (RE) from their business

borrow from friends and relatives (F&R)

less likely to receive government assistance like grants

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…ECONOMIC PROFILE

•Based on SME Census 2011:

4. Technology - usage of ICT in business operations

- YES: 27% (internet users 67% and non-internet users 23%)

- NO: 73%

IRBM provides 12 on-line facilities for tax payers. Among them are e-

registration, e-filing, e-payment, e-updates, e-ledger. IRBM also

provides assistance and tax payer education to tax payers and support

through out reach programmes.

Micro entrepreneurs must be able to read and write especially in

Bahasa Malaysia or English language

and ICT inclined.

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…ECONOMIC PROFILE

5. Tax Compliance

Study on “Tax compliance costs of Bumiputera Small and Medium

Enterprises in Northern Malaysia” for year of assessment 2003 found

that tax compliance costs have a significant relation with the paid up

capital of enterprises (Hafizah Abdul Mansor, UTMara Johor, 2008):

Smaller Bumiputera enterprises incur more internal tax compliance

costs and have a higher percentage of tax compliance costs based

on tax revenue

Bumiputera entrepreneurs lack tax knowledge

With effect from YA 2003, companies with paid up capital less than

RM2.5 million is taxed at 20% on chargeable income up to RM500,000

and the balance at prevailing company tax rate of 25%. Policy to

further promote domestic investment by SMEs.

Create opportunities for tax planning by large companies.

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TAXING MICRO BUSINESSES IN MALAYSIA

POLICY - Why tax micro businesses?

Income Tax Act 1967: gains or profits from a business are subject to tax

1. Micro business includes sole proprietors, self employed, partnerships eg. sundry business, direct selling, stalls, clinics, law firms, writers and actors, remisiers, agriculture and farming

2. No preferential tax rate

3. Subject to scale rates as in personal income tax

4. Eligible for deduction on expenses incurred in the production of income such as allowable business expenses, export allowance and double deductions but exclude personal expenses, purchase of personal assets and initial expenses

5. Eligible for financing from RM1,000 to RM50,000 for use as working capital based on viability of business and solely on creditworthiness of borrower

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CONTRIBUTION OF MICRO BUSINESS TO

FEDERAL GOVERNMENT REVENUE

0

50000

100000

150000

200000

250000

2009 2010 2011

Fed Gov Rev

Sole Proprietor

SME

8.1%8.2%7.6%

1.45%1.6% 1.57%

Source: MOF/IRBM

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DEALING WITH MICRO BUSINESSES IN THE INFORMAL ECONOMY

1. Focus of the Inland Revenue Board of Malaysia

- registration, filing, declaration and payment

2. Segmentation of economic zones

- identify new business activities & owners

- identify those without Income Tax Reference Number and new tax payers

- surveillance on unregistered businesses

- premise visits to visit new/old/high potential business areas

- identify potential audit cases

3. Verification and enforcement

- surveillance to detect unregistered businesses

- information gathering via third parties, mass media, internet

- cooperate with other government agencies

- research and understand industries

- desk and field audits

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…In Informal Economy

4. Tax payer education and outreach program

- conduct workshop and seminars on business record keeping,

accounts, tax computation and tax payment

- provide advisory service on record keeping, laws and

regulations

- set up one stop service center at all IRBM branches

5. Data matching on asset acquisitions and tax payer data base

- compile “enterprise taxpayers profile” arising from stamp duty

paid on property acquisition transactions, motor vehicle

insurance renewals from insurance companies

- matching above with registered tax file and those earning

assets not in tandem with declared income

- new vehicle registrations from the Road Transport Department

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…In Informal Economy

6. On-line services for new and registered tax payers-

* e-ledger: tax payer to check personal details, transactions and

current tax position

* e- registration: individuals or companies to apply for tax file no.

* e- filing: by individuals, tax agents, companies

* e- payment: tax payer pays tax via financial process exchange

* e- update: tax payer update info

* e-data: employer to upload text files

* e-PCB: employer who does not own a computerised payment

system to record employee info, tax installments and tax

payments

* calculator: online calculation of monthly tax installment

* e-SPC: certification that tax is paid in full

* SMS: register mobile phone to access IRBM’s application

* STAMP: e- payment of stamp duties

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MOVING FORWARD

HOW TO TAX MICRO BUSINESSES IN THE INFORMAL SECTOR?

1. Policy perspective-

i. Low contribution to total revenue ie less than 1.6% to total Government revenue and 2.1% to total tax revenue in YA 2011. Should resources be actively directed at micro business?

ii. Adopt common definition for micro and small businesses for purpose of data collection

iii. Shared information among government agencies to identify unregistered tax filers

iv. Broaden indicators for net worth of business entrepreneurs in the informal economy to include purchase of luxury motor vehicles from second hand car importers, personal insurance policies with high monetary value, memberships in trade associations (eg. Ghana) and golf clubs

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MOVING FORWARD

2. Tax administration perspective –

i. Push factors for micro business to migrate from informal economy into formal economy eg. income tax statement is required for application for bank loan and hire purchase, application for tax incentives and government grants and assistance

ii. Facilitate rather than regulate tax compliance

- simplify filing rules eg. tax estimates, monthly deductions, revisions and tax returns

- low tax thresholds for new and genuine micro-businesses

- tax filing based on minimal information

- not required to use service of tax agents

- reduce punitive impact of penalties

- choice of alternative tax base combined with special tax regime eg. receipts from cost of sales, cash flow, turnover

- reward voluntary registration by new businesses

iii. Enhance basic ICT skills and access to on-line services

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CONCLUSION

Taxing micro and small business enterprises in the informal

economy is a balancing act-

* A tax regime that is too restrict will discourage the

development of entrepreneurial spirit and drive

enterprises underground

* A tax regime that offers preferential treatments will discourage

micro business from growing big and move into the formal

economy

TAX ANALYSIS DIVISION

MINISTRY OF FINANCE MALAYSIA

TERIMA KASIH

(THANK YOU)